My doggy nose tells me it is time for the US dollar to have its own thread:

This from today's WSJ

y JUDY SHELTON Unprecedented spending, unending fiscal deficits, unconscionable accumulations of government debt: These are the trends that are shaping America's financial future. And since loose monetary policy and a weak U.S. dollar are part of the mix, apparently, it's no wonder people around the world are searching for an alternative form of money in which to calculate and preserve their own wealth.

It may be too soon to dismiss the dollar as an utterly debauched currency. It still is the most used for international transactions and constitutes over 60% of other countries' official foreign-exchange reserves. But the reputation of our nation's money is being severely compromised.

Funny how words normally used to address issues of morality come to the fore when judging the qualities of the dollar. Perhaps it's because the U.S. has long represented the virtues of democratic capitalism. To be "sound as a dollar" is to be deemed trustworthy, dependable, and in good working condition.

It used to mean all that, anyway. But as the dollar is increasingly perceived as the default mechanism for out-of-control government spending, its role as a reliable standard of value is destined to fade. Who wants to accumulate assets denominated in a shrinking unit of account? Excess government spending leads to inflation, and inflation plays dollar savers for patsies—both at home and abroad.

A return to sound financial principles in Washington, D.C., would signal that America still believes it can restore the integrity of the dollar and provide leadership for the global economy. But for all the talk from the Obama administration about the need to exert fiscal discipline—the president's 10-year federal budget is subtitled "A New Era of Responsibility: Renewing America's Promise"—the projected budget numbers anticipate a permanent pattern of deficit spending and vastly higher levels of outstanding federal debt.

Even with the optimistic economic assumptions implicit in the Obama administration's budget, it's a mathematical impossibility to reduce debt if you continue to spend more than you take in. Mr. Obama promises to lower the deficit from its current 9.9% of gross domestic product to an average 4.8% of GDP for the years 2010-2014, and an average 4% of GDP for the years 2015-2019. All of this presupposes no unforeseen expenditures such as a second "stimulus" package or additional costs related to health-care reform. But even if the deficit shrinks as a percentage of GDP, it's still a deficit. It adds to the amount of our nation's outstanding indebtedness, which reflects the cumulative total of annual budget deficits.

By the end of 2019, according to the administration's budget numbers, our federal debt will reach $23.3 trillion—as compared to $11.9 trillion today. To put it in perspective: U.S. federal debt was equal to 61.4% of GDP in 1999; it grew to 70.2% of GDP in 2008 (under the Bush administration); it will climb to an estimated 90.4% this year and touch the 100% mark in 2011, after which the projected federal debt will continue to equal or exceed our nation's entire annual economic output through 2019.

The U.S. is thus slated to enter the ranks of those countries—Zimbabwe, Japan, Lebanon, Singapore, Jamaica, Italy—with the highest government debt-to-GDP ratio (which measures the debt burden against a nation's capacity to generate sufficient wealth to repay its creditors). In 2008, the U.S. ranked 23rd on the list—crossing the 100% threshold vaults our nation into seventh place.

If you were a foreign government, would you want to increase your holdings of Treasury securities knowing the U.S. government has no plans to balance its budget during the next decade, let alone achieve a surplus?

In the European Union, countries wishing to adopt the euro must first limit government debt to 60% of GDP. It's the reference criterion for demonstrating "soundness and sustainability of public finances." Politicians find it all too tempting to print money—something the Europeans have understood since the days of the Weimar Republic—and excessive government borrowing poses a threat to monetary stability.

Valuable lessons can also be drawn from Japan's unsuccessful experiment with quantitative easing in the aftermath of its ruptured 1980s bubble economy. The Bank of Japan's desperate efforts to fight deflation through a zero-interest rate policy aimed at bailing out zombie companies, along with massive budget deficit spending, only contributed to a lost decade of stagnant growth. Japan's government debt-to-GDP ratio escalated to more than 170% now from 65% in 1990. Over the same period, the yen's use as an international reserve currency—it clings to fourth place behind the dollar, euro and pound sterling—declined from comprising 10.2% of official foreign-exchange reserves to 3.3% today.

The U.S. has long served as the world's "indispensable nation" and the dollar's primary role in the global economy has likewise seemed to testify to American exceptionalism. But the passivity in Washington toward our dismal fiscal future, and its inevitable toll on U.S. economic influence, suggests that American global leadership is no longer a priority and that America's money cannot be trusted.

If money is a moral contract between government and its citizens, we are being violated. The rest of the world, meanwhile, simply wants to avoid being duped. That is why China and Russia—large holders of dollars—are angling to invent some new kind of global currency for denominating reserve assets. It's why oil-producing Gulf States are fretting over whether to continue pricing energy exports in depreciated dollars. It's why central banks around the world are dumping dollars in favor of alternative currencies, even as reduced global demand exacerbates the dollar's decline. Until the U.S. sends convincing signals that it believes in a strong dollar—mere rhetorical assertions ring hollow—the world has little reason to hold dollar-denominated securities.

Sadly, due to our fiscal quagmire, the Federal Reserve may be forced to raise interest rates as a sop to attract foreign capital even if it hurts our domestic economy. Unfortunately, that's the price of having already succumbed to symbiotic fiscal and monetary policy. If we could forge a genuine commitment to private-sector economic growth by reducing taxes, and at the same time significantly cut future spending, it might be possible to turn things around. Under President Reagan in the 1980s, Fed Chairman Paul Volcker slashed inflation and strengthened the dollar by dramatically tightening credit. Though it was a painful process, the economy ultimately boomed.

Whether the U.S. can once more summon the resolve to address its problems is an open question. But the world's growing dollar disdain conveys a message: Issuing more promissory notes is not the way to renew America's promise.

Ms. Shelton, an economist, is author of "Money Meltdown: Restoring Order to the Global Currency System" (Free Press, 1994).

Ben Bernanke's dollar crisis went into a wider mode yesterday as the greenback was shockingly upstaged by the euro and yen, both of which can lay claim to the world title as the currency favored by central banks as their reserve currency.

Over the last three months, banks put 63 percent of their new cash into euros and yen -- not the greenbacks -- a nearly complete reversal of the dollar's onetime dominance for reserves, according to Barclays Capital. The dollar's share of new cash in the central banks was down to 37 percent -- compared with two-thirds a decade ago.

Currently, dollars account for about 62 percent of the currency reserve at central banks -- the lowest on record, said the International Monetary Fund.

Bernanke could go down in economic history as the man who killed the greenback on the operating table.

After printing up trillions of new dollars and new bonds to stimulate the US economy, the Federal Reserve chief is now boxed into a corner battling two separate monsters that could devour the economy -- ravenous inflation on one hand, and a perilous recession on the other.

"He's in a crisis worse than the meltdown ever was," said Peter Schiff, president of Euro Pacific Capital. "I fear that he could be the Fed chairman who brought down the whole thing."

Investors and central banks are snubbing dollars because the greenback is kept too weak by zero interest rates and a flood of greenbacks in the global economy.

They grumble that they've loaned the US record amounts to cover its mounting debt, but are getting paid back by a currency that's worth 10 percent less in the past three months alone. In a decade, it's down nearly one-third.

Yesterday, the dollar had a mixed performance, falling slightly against the British pound to $1.5801 from $1.5846 Friday, but rising against the euro to $1.4779 from $1.4709 and against the yen to 89.85 yen from 89.78.

Economists believe the market rebellion against the dollar will spread until Bernanke starts raising interest rates from around zero to the high single digits, and pulls back the flood of currency spewed from US printing presses.

"That's a cure, but it's also going to stifle any US economic growth," said Schiff. "The economy is addicted to the cheap interest and liquidity."

Economists warn that a jump in rates will clobber stocks and cripple the already stalled housing market.

"Bernanke's other choice is to keep rates at zero, print even more money and sell more debt, but we'll see triple-digit inflation that could collapse the economy as we know it.

"The stimulus is what's toxic -- we're poisoning ourselves and the global economy with it."

Luskin: "obviously, a currency undergoing inflation is worth less than a currency not undergoing inflation"

'Inflation' is the creation of the excess money. Price increases are a symptom likely to follow. So is devaluation. 'Decline is a choice.' Our reckless policies were enabled by our fading, privileged status as the world currency. Unlike third world countries, our debt is in our own currency. Devalue the currency and you devalue the debt. - Doug----

The dramatic recent fall of the value of the U.S. dollar grabs headlines every day, even as the U.S. stock market surges to new recovery highs. People are talking about a "dollar crisis," and it's not just the usual rant-and-rave topic on CNBC. There are serious hints from government authorities around the globe that maybe we should think about dethroning the U.S. dollar as the "reserve currency" held by the world's central banks, and maybe global markets like oil should stop being priced in dollars.

There are some currencies that are as weak as the dollar now, such as the British pound. And there are some that are weaker, such as the Malaysian ringgit. But against a basket of the world's major currencies, the dollar has fallen 15% in just seven months. That's a big move in any market, but for a currency it's practically a crash. If it falls another 6%, it will make historic all-time lows.

You'd think with all this going on, officials at the U.S. Treasury would be running around in a flat-out panic. But they're not. This week I met in Washington with a group of the most senior men at Treasury (please forgive me if I don't name names), and I was surprised to learn that they are not terribly worried.

Here's why.

First, they think that the 15% decline in the dollar is actually a sign of economic strength. They point out, quite correctly, that the value of the dollar surged during the recent credit crisis, as investors around the world suddenly craved the safety of dollar liquidity. At the most, the dollar soared 24%, reaching its top on exactly the same day last March that the stock market made its bottom.

That puts the 15% drop in context. And it also helps to explain why foreign governments are suddenly so interested in dropping their dependency on the U.S. dollar. It's not so much because the dollar is weak. It's because the credit crisis revealed that the dollar is intolerably unique.

By that I mean that when the world economy came off the rails last year, everyone in the world needed dollars — not pounds, not euros, not yen, not yuan, not ringgits — because the U.S. dollar is the de facto unit of global trading and investment. Why should the economies of the world be so dependent on a single nation's currency?

So while it may feel like a blow to our national prestige to have the dollar be just another currency, that's probably inevitable — and probably all for the best. It's in America's interest to live in a world more resilient to credit shocks than the dollar-dominated world turned out to be.

Another reason the Treasury isn't in a twist about the dollar is that they recognize there is nothing they can do about it. Oh, sure, Secretary Tim Geithner could give a speech or two about his "strong dollar policy," for all the good it would do, which would be precisely none. By the way, when I visited Treasury, nobody even mentioned the expression "strong dollar."

The reality is -- and the Treasury knows this -- that it's the Federal Reserve that ultimately determines the value of the dollar. That's because the Fed's monetary policies are what determines inflation —and obviously, a currency undergoing inflation is worth less than a currency not undergoing inflation. So if you want a strong dollar, write a letter to Fed Chairman Ben Bernanke, not Geithner.

There is one thing that the Treasury could do to support the dollar. But what I heard this week in Washington convinces me that they aren't going to do it. They are going to do the exact opposite.

What I mean is that the Treasury is going to every diplomatic means at its disposal to get countries like China to make their currencies more valuable vs. the dollar. Rightly or wrongly, the Obama administration's Treasury believes — exactly as the Bush administration's Treasury did — that China, and other giant exporting nations manipulate their currencies, to keep them cheap so that their exports will be cheap on world markets.

U.S. consumers benefit from cheap foreign goods at Wal-Mart. But U.S. manufacturers can't compete with the foreign manufacturers that make those cheap goods. And U.S. manufacturers make bigger political contributions than U.S. consumers. So the Treasury, naturally, is committed to getting governments like China to effectively raise their prices by appreciating their currencies.

Now when Treasury officials talk about this, they don't admit that they're trying to get China to stop manipulating its currency lower and start manipulating it higher. Instead, they say they want China to stop manipulating it altogether, on the theory that when the yuan floats freely on world markets, it will inevitably move higher.

Maybe it will and maybe it won't. But there's one inescapable truth here — at least when it comes to the Chinese yuan and several other exporting nations' currencies: They want the value of the dollar to be lower. There's no way around it. If you want the yuan to be higher relative to the dollar, then you necessarily want the dollar to be lower relative to the yuan.

So let's put it all together. I'm not worried that there's going to be some kind of "dollar crisis." But all the facts do point to a lower dollar.

First, if the Fed ultimately controls the dollar's value, then the dollar is going lower — with interest rates at zero for as far as the eye can see, inflation is inevitable.

Second, if the dollar gets stronger during times of credit stress, the dollar is going lower — because global credit markets are recovering, and getting stronger every day.

Third, the Treasury will be actively pursuing diplomacy to get China and other exporters to strengthen their currencies, so the dollar is going lower.

While all the talk at present is about economic corners turned and markets charging ahead, no one is paying much notice to an American economy deteriorating before our eyes. These myopic commentators seem to be simply moving past the now almost-universally held conclusion that before the crash of 2008, our economy was on an unsustainable course. If these imbalances had been corrected, then perhaps I too would be joining in the euphoria. But evidence abounds that we have not veered at all from that dangerous path.

Last week, the Bureau of Economic Analysis reported that consumer spending as a percentage of U.S. GDP has risen to 71%, a post-World War II record. This level is notably higher than other wealthy industrialized countries, and vastly higher than the levels sustained by China and other emerging economies. At the same time, our industrial output is contracting, our trade deficit is expanding once again (after contracting earlier in the year), and our savings rate is plummeting (after an early year surge).

The data confirms that government stimuli are worsening the structural imbalances underlying our economy. The recent ‘rebound’ in GDP is not resulting from increased economic output, but merely from the fact that we are borrowing more than ever. That is precisely how we got ourselves into this mess. An economy cannot grow indefinitely by borrowing more than it produces. Not only is such a course untenable, but the added debt ensures a deeper recession when the bills come due.

This soon-to-be-called depression will not end until the pendulum of consumer spending habits swings violently in the other direction. This will be a jarring change, but it is the splash of cold water that we need to return our economy to viability. I believe that consumer spending as a share of GDP will need to temporarily contract to roughly 50% of GDP, before eventually moving toward its historic mean of 65%. Such a move would indicate a restoration of our personal savings, a decline in borrowing and trade deficits, and an increased industrial output. That would be a real recovery.

In the meantime, the higher the spending percentage climbs, the more painful the ultimate decline becomes.

Consumers and governments must spend less so their savings can be made available to businesses for capital investments. Businesses, in turn, will produce more products and employ more people – increasing domestic prosperity. However, rather than allowing a painful cure to return our economy to health, the government prefers to numb the voting public with a toxic saline-drip of deficit spending and cheap money.

The primary factor that enables our government to peddle economic snake oil is the dollar’s unique role as the world’s reserve currency, and our creditors’ willingness to preserve its status. By buying up dollars and loaning them back to us through Treasury debt, productive countries give American politicians carte blanche to play Santa Claus.

Ironically, as foreign governments finance our spending spree, they are simultaneously scolding us for our low savings rate. At the recent G20 meeting in Pittsburgh, all agreed – including President Obama – that resolving the global economic imbalances was a top priority. By definition, this would require Americans to spend less and save more. However, with foreign central banks continuing to buy our debt, the President has shown no political will to encourage this change.

Normally, if politicians run up the government deficit, voters soon suffer the unpleasant consequences of higher inflation and rising interest rates. Yet, if foreign central banks keep supplying the funds, these consequences are indefinitely postponed. As a result, there is no need for American politicians to ever make the tough choices required to solve our problems.

Instead, the burden may fall squarely on the citizens of those governments doing all the lending. The conflict is that within the creditor states, a vocal minority actually benefits from this subsidy (owners of Chinese exporters, for example) while the overwhelming majority fails to make the connection. Thus, foreign politicians have the same incentives as ours to keep playing the game.

The bottom line is that foreign governments can lecture us all they want about the need for prudence but if they keep lending, we’ll keep spending. Any parent knows that if you give your child a curfew yet never impose any penalties when it’s violated, it will not be respected. My gut feeling is that foreign governments are tiring of our conduct and on the verge of finally imposing some discipline. That means the dollar’s days as the world’s reserve currency are numbered, and the days of American austerity are about to begin.

We make our case for the Fed to increase short-term interest rates to a more normal 2% -- or risk fostering another financial bubble.

IT'S TIME FOR THE FEDERAL RESERVE TO STOP talking about an "exit strategy" and to start implementing one.

There's no need for short-term rates to remain near zero now that the economy is recovering. The call to action is clear: Gold, oil and other commodities are rising, the dollar is falling and the stock market is surging. The move in the Dow Jones industrial average above 10,000 last week underscores the renewed health of the markets. Super-low short rates are fueling financial speculation, angering our economic partners and foreign creditors, and potentially stoking inflation.

The Fed doesn't seem to be distinguishing between normal accommodative monetary policy and crisis accommodative policy. There's a huge difference.

With the crisis clearly past, the Fed ought to boost short-term rates to a more normal 2% -- still low by historical standards -- to send a signal to the markets that the U.S. is serious about supporting its beleaguered currency and that the worst is over for the global economy. Years of low short rates helped create the housing bubble, and the Fed risks fostering another financial bubble with its current policies.

The Fed also ought to consider scaling back its massive bond purchases, which have totaled more than $1 trillion this year and have artificially depressed mortgage and Treasury interest rates. The Fed has virtually cornered the mortgage-backed market, buying about 75% of newly created government-backed securities this year, and that has forced the usual institutional buyers of mortgage securities into other markets, like corporate and municipal bonds. This has contributed to the sharp rally in munis and corporates.

Better to stop the Fed's bond-buying program sooner rather than later, and end artificially low, sub-5% mortgage rates. The more securities the Fed purchases, the greater the ultimate losses on its holdings when rates do rise. Banks also have bulked up on low-yielding Treasuries, buying over $200 billion in the past year.

It's also time for the Fed to consider the plight of the country's savers, who now are getting less than 1% yields on money market funds and who are being forced to take substantial interest-rate or credit risk if they want higher yields. "The Fed is punishing prudent people and rewarding profligate people," one veteran investor tells Barron's. Many unemployed and underemployed Americans may be deserving of some mortgage relief, but there also are millions of Americans -- most of them elderly -- who diligently saved and now have little income to show for a lifetime of effort.

WHILE SAVERS ARE SUFFERING AND MAIN STREET is hurting from still-tight bank lending policies, Wall Street is having one of its best years ever -- and rock-bottom short-term rates are a key reason. Goldman Sachs (GS) and JP Morgan (JPM) last week reported strong third-quarter profits, stemming in large part from trading activities. A flush Goldman is on course to pay $20 billion to its employees in 2009 -- or nearly $700,000 per person -- just a year after the wobbling firm got a critical government financial safety net. Goldman generated over 80% of its revenues from trading in the third quarter.

A quick move up to 2% -- or even 1% -- in the key Federal funds rate, now at just 0.15%, might shock global markets, where big investors have come to see the dollar, commodities and stocks as one-way bets. Major global equity indexes probably would fall, while commodities likely would fall and the dollar would rally.

Ultimately, higher short-term rates could help by suppressing incipient inflation while doing little to dampen a mending U.S. economy. Real GDP growth could top 3% in the second half of this year.

Our view unquestionably is an outlier. With unemployment near 10%, few see a need for higher rates. And Fed chairman Ben Bernanke, while acknowledging that the Fed will need to pursue an "exit strategy" and tighten monetary policy, clearly wants to act later rather than sooner.

"My colleagues at the Federal Reserve and I believe that accommodative policies will likely be warranted for an extended period," he said recently. Financial markets expect the pace of Fed tightening to be very slow, with short-term rates not hitting 1% until October of 2010.

But some central-bank officials, such as St. Louis Fed President James Bullard, have been warning about inflation. And they have a point: Inflation is back, with prices rising 0.2% in September after increasing 0.4% in August. The CPI index could be up 2% in the next year, versus a 1.3% decline in the 12 months through September.

THE STOCK MARKET HAS BECOME A WEAK-DOLLAR constituency because a declining greenback boosts profits of multinational companies like Coca-Cola (KO) and Intel (INTC). Overall, companies in the S&P 500 get 30% of their revenues from abroad.

But maintaining the status quo could be short-sighted, since overseas investors are likely critical to the long-term health of the U.S. stock market. They've been burned by U.S. stocks in the past decade; the market's decline and a weaker dollar have meant 50% losses for European holders. If the U.S. wants to continue to attract overseas capital, it's going to need to support its currency.

Speculators, meanwhile, have been borrowing in dollars to buy a range of financial assets because of near-zero borrowing costs and the prospect of repaying those loans with a depreciated currency.

Low U.S. interest rates aren't the only problem for the dollar. Many foreign investors have been spooked by the record budget deficit and a perception that the Obama administration wants a lower dollar to boost exports and the economy.

The chances of the Fed moving away soon from a crisis-accommodative stance and near-zero short-term rates probably are small, because doves like Bernanke have the upper hand. There isn't apt to be any political pressure to raise rates.

That's a shame. The Fed and the administration are playing a dangerous financial and fiscal game because ours is a debtor nation that depends on the confidence of overseas creditors. If a resilient U.S. economy can't tolerate 1% or 2% short rates, this country really is in bad shape.

By JUDY SHELTON This past Sunday, at the American Economic Association's annual meeting in Atlanta, Ga., Federal Reserve Chairman Ben Bernanke offered up a lengthy, professorial defense of U.S. monetary policy over the last decade, focusing on its role in the financial crisis that has gripped the world economy.

It doesn't quite rise to the level of Homeland Security Secretary Janet Napolitano's claim after a barely foiled attempt to blow up a U.S.-bound airliner on Christmas Day that "the system worked really smoothly." But Mr. Bernanke's calm observation that "monetary policy from 2002 to 2006 appears to have been reasonably consistent with the Federal Reserve's mandated goals of maximum sustainable employment and price stability" is nevertheless disturbing.

If the integrity of the dollar is not the Fed's primary concern, or if its notion of "price stability" is restricted to some narrow core inflation index that does not include escalating costs for food and energy, let alone runaway prices for financial market assets and commodities, then the Fed is woefully inadequate to the task of safeguarding the value of our nation's money.

Mr. Bernanke is not oblivious to criticism of the Fed's role in the crisis. His assertion that "regulatory and supervisory policies, rather than monetary policies, would have been more effective means of addressing the run-up in house prices" hints at a possible scapegoat for the housing bubble that presaged financial calamity.

Yet nowhere in his 34-page apologia does the Fed chairman fault Congress for inflicting Fannie Mae and Freddie Mac on the home mortgage industry; nowhere does he attempt to analyze the damaging influence of government intervention in the private sector, or its distorting impact on market assessments of risk-and-return tradeoffs.

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Getty Images .Instead of trying to shift blame away from the easy-money policies of the Fed that accommodated such ill-considered government intrusion into the mortgage-lending business—spawning a treacherous boom in exotic derivative instruments structured against seemingly endless supplies of securitized U.S. debt—Mr. Bernanke should strive to better explain why the Fed ignored troubling indications of a growing bubble.

According to U.S. Census Bureau statistics, the average sales price of a new home in 2000 was $207,000; the average price in 2007 was $313,600, more than 50% higher in just seven years. During the same period, based on Consumer Price Index (CPI) numbers for the interim years provided by the Bureau of Labor Statistics, the average sales price of a new home should have been $250,625 in 2007—that is, if the CPI fully captured the impact of excessive monetary issuance.

In other words, if you assume stable demand and supply, the government's official CPI calculation only accounts for a 21% gain in the average sales price of a new home from the beginning of the decade to the start of the subprime collapse.

Mr. Bernanke glosses over this significant anomaly. He notes breezily in last Sunday's speech that the most rapid price gains in housing occurred in 2004 and 2005. But it's worth reminding the chairman that the Fed kept the federal-funds rate at a then-record low of 1% from June 2003 to June 2004. The most Mr. Bernanke concedes is a begrudging admission that "the timing of the housing bubble does not rule out some contribution from monetary policy."

OpinionJournal Related Stories:Review & Outlook: The Bernanke Record Review & Outlook: Dear Chairman Bernanke Review & Outlook: Bernanke's Second Chance .When it comes to evaluating Fed performance, the Fed itself always seems to get back to using core inflation measures. What about changes in the value of the dollar against other major currencies during the last decade? Shouldn't a decline in global purchasing power for all Americans qualify for consideration in Fed deliberations over appropriate monetary policy?

If price stability constitutes one of the Fed's key objectives, the fact that the dollar went from being worth 1.17 euros in October 2000 to a mere .63 euros in April 2008—roughly half as much—would seem to matter. Should the value of U.S. money really be subject to swings of such magnitude? The dollar's current exchange rate of .69 euros no doubt reflects the "safe haven" status of U.S. investment at times of shaky global finances; it's a residual privilege we seem poised to lose as fiscal imbalances mount.

And what about gold? The price of gold has soared to $1,128 today from $282 at the beginning of the decade, a fourfold increase. During the critical 2002-2006 period—when Mr. Bernanke insists monetary policy was consistent with the Fed's price-stability goals—the dollar price of gold climbed steadily to $700 from below $300. Did the governors of our nation's central bank not notice? Given that the U.S. government holds the largest amount of official gold reserves in the world, it would seem pertinent.

Indeed, gold is viewed by central banks the world over as a unique reserve asset. Contrary to monetary assets denominated in national currencies, its status cannot be undermined by inflation in the issuing country, nor is it subject to repudiation or default.

Which suggests that perhaps it is time to make available to the American public the sort of insurance against dollar depreciation that monetary authorities have long sought for their own portfolios. For those citizens who've become skeptical of the Fed's ability to guarantee price stability in terms more meaningful than elementary CPI statistics—or who believe the bigger threat to their personal financial security lies in a potential repeat of the last debacle—why not provide a new class of Treasury obligations that would guarantee the purchasing power of the dollar in terms of gold?

It would not necessarily be a difficult task. Congress could pass legislation authorizing a limited issuance of gold-backed Treasury notes in compliance with existing legal restrictions pertaining to U.S. savings bonds (to own U.S. savings bonds you must be a U.S. resident and have been issued a Social Security number). The five-year Treasury notes would pay no interest, but they would provide for payment of principal at maturity in either ounces of gold or the face value of the security, at the option of the holder.

In the same way that inflation-indexed Treasury obligations provide an indication to the Fed of aggregate expectations on consumer prices, gold-backed Treasury notes would offer an additional useful tool for conducting monetary policy—one more broadly reflective of potential bubbles in both financial markets and commodities.

Don't be surprised, though, if the Fed balks at the proposal. When it comes to the golden canary, it has already proven itself tone deaf.

Ms. Shelton, an economist, is author of "Money Meltdown: Restoring Order to the Global Currency System" (Free Press, 1994).

Federal Reserve earned $45 billion in 2009By Neil IrwinWall Street firms aren't the only banks that had a banner year. The Federal Reserve made record profits in 2009, as its unconventional efforts to prop up the economy created a windfall for the government.

The Fed will return about $45 billion to the U.S. Treasury for 2009, according to calculations by The Washington Post based on public documents. That reflects the highest earnings in the 96-year history of the central bank. The Fed, unlike most government agencies, funds itself from its own operations and returns its profits to the Treasury.

The numbers are good news for the federal budget and a sign that the Fed has been successful, at least so far, in protecting taxpayers as it intervenes in the economy -- though there remains a risk of significant losses in the future if the Fed sells some of its investments or loses money on its stakes in bailed-out firms.

This turn of events comes as the banks that benefited from the Fed's actions are under the microscope. Starting at the end of the week, major banks are expected to announce significant earnings and employee bonuses. Anger in Washington is at such a high boil that the Obama administration will probably propose a fee on financial firms to recoup the cost of their bailout, officials confirmed Monday.

As it happens, the Fed's earnings for the year will dwarf those of the large banks, easily topping the expected profits of Bank of America, Goldman Sachs and J.P. Morgan Chase combined.

Much of the higher earnings came about because of the Fed's aggressive program of buying bonds, aiming to push interest rates down across the economy and thus stimulate growth. By the end of 2009, the Fed owned $1.8 trillion in U.S. government debt and mortgage-related securities, up from $497 billion a year earlier. The interest income on those investments was a major source of Fed profits -- though that income comes with risks, as the central bank could lose money if it later sells those securities to reduce the money supply.

The Fed also made money on its emergency loans to banks and other firms and on special programs to prop up lending, such as one that supports credit cards, auto loans, and other consumer and business lending. Those programs impose interest and fees on participants, with the aim of ensuring that the Fed does not lose money.

And while the central bank in its most recent financial report had recorded a $3.8 billion decline in the value of loans it made in bailing out the investment bank Bear Stearns and the insurer American International Group, the Fed also logged $4.7 billion in interest payments from those loans. Further losses -- or gains -- on the two bailouts are possible as time goes by. The Fed also charges fees for operating the plumbing of the financial system, such as clearing checks and electronic payments between banks.

From its revenue, the Fed deducts operating expenses, such as employee salaries, then returns to the Treasury almost all of the earnings that remain. The largest previous refund to the Treasury was $34.6 billion, in 2007.

"This shows that central banking is a great business to be in, especially in a crisis," said Vincent Reinhart, a resident scholar at the American Enterprise Institute and a former Fed official. "You buy assets that have a nice yield, and your cost of funds is very low. The difference is profit."

The Fed plans to release its estimate of 2009 earnings Tuesday. The Post's calculation is based on combining data through September from the Fed's monthly balance sheet report with more recent data from the Treasury's daily budget statement.

Fed officials do not make policy with an eye toward maximizing profits. They are charged by law with managing the nation's money supply to keep employment high and prices stable, and earnings fluctuate depending on a wide range of factors as they pursue that goal. In the crisis, the central bank's policy has been to create money and use it to buy a wide variety of assets, which in turn pay interest.

In effect, the unprecedented range of actions taken to address the crisis has made the Fed's balance sheet more like that of a private bank. A firm such as Bank of America takes money from depositors, whom it pays little or nothing in interest, and lends it out at significantly higher rates. The Fed, similarly, takes money that banks keep on deposit, at a rate of 0.25 percent, and lends it to the U.S. government by buying Treasury securities and, lately, to home buyers and other private borrowers though more exotic investments.

While that resulted in higher earnings in 2009, it exposes the Fed to more risks down the road. "They've moved up the risk-return curve, as they have more long-term assets and more things that involve credit risk," said Diane Swonk, chief economist at Mesirow Financial.

If the price of Treasury bonds or mortgage-related securities issued by Fannie Mae and Freddie Mac were to fall in the years ahead, and Fed leaders decided they need to drain money from the financial system by selling off some of their portfolio, the central bank would lose money. "If they do enough asset sales and rates go high enough, that could eat into future profits pretty substantially," said Michael Feroli, an economist at J.P. Morgan Chase.

Even as the Fed comes to resemble private banks in terms of its balance sheet and its earnings power, there remains one big difference. The CEO of the Federal Reserve, Chairman Ben S. Bernanke, received a modest cost-of-living raise for 2010, despite the record earnings: He now makes $199,700, with no bonus at all.

Fed conspiracists (often Libertarians, also far left anti-capitalists) seem to be able to read that headline: "Federal Reserve earned $45 billion in 2009" and not the following sentence: They returned all the profit to the U.S. Treasury. "Bernanke...now makes $199,700, with no bonus at all." - About the same as your local superintendant of schools and a fraction of the typical NCAA public university basketball coach salary.

I love to criticize and second guess the Fed's work but they aren't at least directly stealing from us.

The HELL they are not!!! With near zero interest rates for savers (or negative if one counts, as one should, inflation and taxes) and the destruction of the currency-- they are stealing plenty from me and from every American who looks to save.

The consensus expects the Treasury deficit to fall from $120 billion in November to $92 billion in December. The estimate is in-line with the latest Congressional Budget Office forecast.

The CBO puts together a monthly budget preview based upon daily Treasury estimates. The CBO's estimate of a $92 billion deficit is $40 billion higher than what was recorded in December 2008. When adjusted for timing changes, the deficit only increased by $11 billion.

Federal tax receipts are expected to decline by $18 billion from December 2008 to $220 billion. Half of the drop in receipts is attributed to holiday timing changes and the rest is due to tax relief provided by the American Recovery and Reinvestment Act of 2009.

Outlays are expected to increase $22 billion from December 2008 to $312 billion. Most of the increase was due to shifting of payments due to holidays and a $13 billion payment to Fannie Mae.

The market generally does not trade on the deficit numbers, but the steady decline in the value of the dollar over the last few months may accelerate if the deficit comes in much wider than expected.

I saw something this AM to the effect that the Fed is not going to be using the Fed Funds rate as its key tool and instead will be using , , , several things. I did not fully comprehend the conversation, but it smelled highly significant. Has this crossed anyone else's radar screen?

Today's edition of the WSJ reports Federal Reserve Chairman Ben Bernanke will begin this week to lay out a blueprint for a credit tightening, to be followed once the Fed decides the economy has recovered sufficiently. The centerpiece will be a new tool Congress gave the central bank in October 2008: an interest rate the Fed pays banks on money they leave on reserve at the central bank. Known as "interest on excess reserves," this rate is now 0.25%.

The Fed is still at least several months away from raising interest rates or beginning to drain the flood of money it poured into the financial system in 2008 and 2009. But looking ahead to when the economy is strong enough to warrant tightening credit, officials have been discussing for months which financial levers to pull, when to start and how best to communicate their intent. When the Fed is ready to tap the brakes, it plans to raise the rate paid on excess reserves, according to Fed officials in interviews and recent speeches. The higher rate would entice banks to tie up money they otherwise might lend to customers or other banks. The Fed expects such a maneuver to pull up other key short-term rates, including the federal-funds rate at which banks lend to each other overnight—long the main tool for steering the economy.

The HELL they are not!!! With near zero interest rates for savers (or negative if one counts, as one should, inflation and taxes) and the destruction of the currency-- they are stealing plenty from me and from every American who looks to save.

Tools/ Improvements for the family farm, and other things I have been putting off because they were nice to have for safety, but not critical. Moving some money into silver and a local bank without a bunch of real estate exposure. I am thinking that if we get 1970's inflation coupled with an active move to change the world standard currency, it may be better to have "things" than "paper".

The Economy is not looking good. The Health Care bill with its criminal clauses. I seem to feel a general anger expressed by people too. The way the other real estate shoe is gonna drop in March with the commercial real estate adjusting, with more of the "Fancy Mortgages" also coming due.

I am getting that "Itch" that has served me as a warning at other times, and ignoring it resulted in 1 hospital trip, I haven't ignored it since. Paying attention served to have things miss me, so......... call it superstition if you want.

The pace and severity of financial crises has taken an ominous turn for the worse. Over the past 30 years, a crisis has occurred, on average, every three years. Yet, now, only 18 months after the meltdown of late 2008, Europe’s sovereign debt crisis has hit with full force. With one crisis seemingly begetting another, and the fuse between crises now getting shorter and shorter, the world economy is on a very treacherous course.

In the aftermath of the Asian financial crisis of the late 1990s, über monetary accommodation fed the equity bubble. Once that bubble burst in 2000, another dose of extraordinary monetary ease set the stage for massive property and credit bubbles. The aftershocks of that post-bubble carnage have now brought Europe to the brink.

Sadly, central banks are doing it again – policy rates near the zero bound in nominal terms and negative in real terms. And in the parlance of the Federal Reserve, this destabilizing condition is likely to persist for an “extended” period. As day follows night, this is a recipe for the next crisis. Whether that crisis is spawned by another asset bubble, a credit binge, or CPI inflation is impossible to say. But any – or all – of these options are conceivable in yet another undisciplined post-crisis climate.

Breaking this daisy chain won’t be easy. But a new approach is desperately needed. History gives us a guide as to how and where to find the answer. Think back to the late 1970s. At the time, there was a deep-rooted sense of despair and hopelessness over the seemingly intractable Great Inflation. Politicians and policy makers were convinced that the system was unwilling – or perhaps unable – to accept the pain of the cure. Sound familiar?

Paul Volcker dispelled that notion – breaking the back of inflation by pushing the federal funds rate up to 19 per cent in 1981. Just as monetary discipline was the answer nearly 30 years ago, I suspect it is the only way out today. For a world in the depths of crisis and despair, another “Volcker moment” may well be at hand.

No, I am not suggesting that central banks tighten monetary policy in the midst of a crisis. But it is high time to banish the moral hazard of macro policy – the false sense of security provided by open-ended fiscal and monetary accommodation as the world lurches from crisis to crisis. Central banks need to lead the way in regaining policy traction by laying out credible and transparent exit strategies from the unprecedented stimulus now in place.

Three things are required here: an explicit target for a “normal” policy rate; a macro forecast that would identify the conditions under which this normalization would occur; and a specific timetable of adjustments in the policy rate that would achieve this result.

As an example of how this approach might work, consider the task of the Federal Reserve.

Step One: Announce a target of restoring the real federal funds rate back to its long-term average of 2 per cent.

Step Two: Lay out a three-year macro forecast of the US economy. For the sake of argument, plug in average real GDP growth and inflation of 2.5 per cent and an unemployment rate that falls back to 6 per cent by the end of 2013.

Step Three: Conditional on that forecast coming to pass, announce a normalization plan of nine moves of 50 basis points in the federal funds rate – spread out over 18 months and commencing as soon as the dust settles on the euro crisis.

This is a hypothetical example of how a new approach might work. Admittedly, it is predicated on an imperfect forecast, and hostage to forces that might render that forecast wide or short of the mark.

But it has the advantage of identifying the parameters of a restoration of monetary discipline – something that has been sorely missing over the past 15 years. And it avoids the perils of the “asymmetrical reaction function” – the aggressive monetary easing in a crisis followed by the baby steps of post-crisis normalization that have allowed the “cure” of one crisis to sow the seeds of the next one.

Central banks are imperfect institutions – and more so in recent years as they have abdicated their political independence. They were outstanding in waging the battle against inflation. They have failed in managing the post-inflation peace. The only hope for a crisis-prone world is a new battle plan.

Stephen Roach is the Chairman of Morgan Stanley Asia and author of The Next Asia (Wiley 2009).

Good subject for conversation, but I dunno about those prescriptions. I know I've heard Roach's name before but can't place him. I have him vaguely filed as "wrong as a usual matter" but I could be wrong about that. Regardless, what he calls for here sounds like an awful lot of forecasting and planning , , , by the very people who and institutions which didn't see all this coming. Volcker's actions (which I followed closely as a econ minor at the U of PA while taking a few courses at the Wharton Biz school) were in the context of high inflation, an economy which was running at a high % of capacity, a rapidly declining dollar, a federal government that was about 20-21% of GDP, competition between the private and public sectors to borrow money, lower entitlements with more people working and paying taxes per person taking entitlements, and a federal deficit that was, working from memory here about 3% of GDP and national debt was , , , 40%? of GDP. It is not clear to me that our current situation tracks that situation closely. We have plenty of excess capacity, as the Euro falls, the dollar rises in relation to it, the Fed govt is about 26-28% of GDP, the banking sector is playing the carry trade, entitlements have expanded dramatically and the ratio of working people to entitled people is seriously bad and getting worse (e.g. 2.x people working for every one person on Social Security, which has already gone negative 6 years ahead of projections; and we have Federal deficits of some 10% of GDP as far as the eye can see and in a few years national debt will be 100% of GDP and we don't even think about unfunded liabilities. Any solution that does not confront that we are spending more than we make/create is irrelevant at best.

The Worldwide Crack Up Boom, According to Ludwig Von MisesBy Bill Bonner • June 26th, 2007 • Related Articles • Filed Under About the AuthorBest-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.See All Articles by This Author

None FoundFiled Under: Market The Worldwide Crack Up Boom, According to Ludwig Von Mises9.6108A kiss is still a kiss. A sigh is still a sigh. And a bubble is still a bubble.

When a kiss is over, it's over. When a bubble pops...well...that's all she wrote! All kisses end - even the wettest "French" kisses. And so do all bubbles - even sloppy mega-bubbles of liquidity. This one will be no exception. But of course, it's not the certainties that make life interesting...it's the uncertainties - the known unknowns and the unknown unknowns, as Mr. Rumsfeld says. We are all born of woman and end up where all men born of women end up - dead. But that doesn't mean we can't have some fun between baptism and last rites.

You'll remember we said that this worldwide financial bubble is both worldlier, and more financial than any in history.

And, for the moment, it is very much alive. So much alive that the media can hardly keep up with it. Forbes magazine, for example, tries to estimate the wealth of the world's richest people. But the rich don't typically give out their balance sheets, telephone numbers and home addresses. So, there's a fair amount of guesswork in the calculations.

But when it came to guesstimating the net worth of Stephen Schwarzman, founder of Blackstone, the Forbes crew wandered off into fiction. They put his wealth at about $2 billion. Recent filings in connection with the new Blackstone IPO show he earned that much in a single year!

In this phase of the bubble, it is as if your neighbors were throwing a wild party - and you weren't invited. You detest them... envy them... and want to join them, all at once. A very small part of the population is having a ball; everyone else is getting restless and wondering when the noise will stop.

We wish we knew. And we've given up guessing.

Meanwhile, the experts, commentarists, kibitzers and analysts are saying that there is a whole new phase of the giant bubble about to unfold; things could get a whole lot crazier. Even many of our respected colleagues are pointing to a text by the great Austrian economist, Ludwig von Mises, for a clue. What we have here, they say, is what Mises described as a "Crack-Up Boom."

Before we go on, readers should be aware that the "Austrian school" of economics is probably the best theory about the way the world works. Like The Daily Reckoning, it is suspicious of efforts to control the natural workings of an economy, in general...and suspicious of central banking, in particular. The fact that it was a one-time "Austrian," Alan Greenspan, who became the most celebrated central banker in history, only increases our suspicions. He was able to master central banking, we imagine, because he understood what it really is - a swindle.

What is a "Crack-Up Boom?" Von Mises explains (with thanks to Ty Andros for reminding us):

"'This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.'"But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against 'real' goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

"It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last."

Mises is describing the lunatic phases of a classic inflationary cycle.

At first, no one can tell the difference between a real dollar - one that is earned, saved, invested or spent - and one that just came off the printing presses. They figure that the new dollar is as good as the old one. And then, prices rise...and people don't know what to make of it. Later, they begin to catch on...and all Hell breaks loose.

You see, if you could really get rich by printing more currency, Zimbabweans would all be as rich as Midas, since the Mugabe government runs the presses night and day.

Von Mises died in 1973 - long before this boom really got going - let alone cracked up. He may never have heard of a hedge fund...or even a derivative, for that matter. A world money system without gold? He probably couldn't have imagined it. People spending millions of dollars for a Warhol? Twenty million for a house in Mayfair? Chinese stocks at 40 times earnings? He would have chuckled in disbelief. He understood how national currency bubbles expand and how they pop, but he probably never would have imagined how insane things could get when you have a whole world monetary system in bubble mode.

He'd have recognised the beginning of this bubble...and he'd have recognised the end, but the middle...or the beginning of the end - that would have dumbfounded him. During his lifetime he saw a Crack Up Boom in Germany in the '20s...and a few more here...but he never saw a worldwide Crack Up Boom.

No one, anywhere, has ever seen a worldwide Crack Up Boom. We're the first, ever. Pretty exciting, huh?

"...I dunno about those prescriptions." - I'm not fully on board the prescriptions but the idea is to pre-announce to the markets that interest rates will not be staying at the 0% emergency levels indefinitely.

"Volcker's actions... - It is not clear to me that our current situation tracks that situation closely." - Very true, but he is talking about trying to rates up to 2% where Volcker had them up near 20%(?)

"...we have Federal deficits of some 10% of GDP...national debt will be 100% of GDP" - THAT is the heart of the matter. There is no perfect monetary policy for a fiscal policy that out of whack. Why should the deck chairs be straight as the ship sinks. This is worse than an accident at sea. We aimed for the rock that broke the hull.

Going back to Volcker, the damage there was done because the tightness of money was supposed to be coupled with the stimulus of tax cuts. In this situation, we need spending control and fiscal sanity. We need success with the political movement that says expanding government and printing play money is no way to stabilize, survive or prosper. But then the Fed needs to right-size its rates before we head back to Jimmy Carter levels of inflation.

Said with love, but I think you have been distracted by matters that are essentially irrelevant. Fed announcements about interest rate policy and all the rest of it ultimately are not the point.

The point is this: We are living beyond our means. Government spending is out of control, and it is already in the entitlement pipeline that it will be more out of control. If we cut it back, then all will be well. If we don't, it won't.

"Said with love, but I think you have been distracted by matters that are essentially irrelevant. Fed announcements about interest rate policy and all the rest of it ultimately are not the point. The point is this: We are living beyond our means. Government spending is out of control, and it is already in the entitlement pipeline that it will be more out of control. If we cut it back, then all will be well. If we don't, it won't."----

I agree, but those are matters of fiscal policy.

Moving on, the Rand Paul matter brings up again the 'End the Fed' question, coincidentally a book title by Ron Paul and a proposal I just heard Glen Beck make a similar proposal on the radio. Beck then backed off slightly by saying 'not just end the Fed and that's it, but I'm talking about a total transformation'.

My opinion could come right out of the Crafty quote above. The corrections we need are fiscal, the excess spending and unfunded entitlements. I would NOT end the Fed. I don't think that is realistic operationally, and I don't think proposals that won't happen are helpful politically.

I have a hole in my understanding. Before we came off the gold standard there were boom and bust cycles. These were caused by what? Now we have come off the gold standard and have lost 95% of the value of the dollar and we still have boom and bust cycles. It is my understanding the fed was put in place to try and stop these ups and downs. So what is the upside of the fed. A semi governmental organization which we have no real oversight. I would rather have the stability of gold and control over my destiny and ride the boom and bust cycles out than be at the mercy of unknown oligarchies. Where should I look to fill the hole in my understanding?

Nice post Freki. This is a difficult subject. That I see it a little differently doesn't mean there is a hole in your understanding. The main point I was making is that I think we are past the point of being capable of reverting back to a true gold standard where all the new dollars are convertible back to gold. For one thing I don't think most dollars are even paper much less gold. Dollars today are largely electronic entries transferred around between banks and institutions, credit card companies, employers, consumers, governments, etc.

By looking past the peaks and troughs on the chart it also looks like the rate of decline in purchasing power was similar in all the periods - before we went off true convertibility in 1933, from 1933 through 1971 when we were forced to go off the Bretton Woods link to gold, and from 1971 to the present.

The criticism that it is a semi governmental organization which we have no real oversight is valid. Congress has 'oversight' but not operational control when they haul the Fed chair in for regular questioning. But IMO that is far better than letting the politicians (spenders) have more direct control.

If true convertibility to gold isn't possible anymore, they talk instead about tracking the dollar's purchasing power with a basket of goods where the price of gold would be a strong component because of its strong reputation for holding its value. The actual tracking of purchasing power is tricky because the mix of goods and services we buy changes over time. If there was a formula instead of a Fed, I think we would still need a board (The Fed)to tweak that formula over time.

"what is the upside of the fed"(?)

It seems to me that there needs to be a human hand able to make an adjustment, a pressure relief, emergency assistance or human judgment to avoid a run, a panic or a collapse, especially in these times. We faced a deflation scare recently and we always seem to face an inflation threat. We had a country go under. We have states going under. We've had market crashes. We had one allegedly triggered by a computer glitch. I remember a near-cornering of the silver market by two brothers. We have droughts, trade imbalances and we have budget shortfalls in the trillions. We've had foreign wars and we had attacks on the homeland with our own planes that shut down entire industries. With a little discipline we could avoid some of these catastrophes, but not all of them.

Let's look at it politically. End the Fed means going back to pre-1913 policies (?) A lot has changed since then and we certainly have a lot of needs for the contingencies partly listed above. Even if that were great policy I think the idea would scare the hell out of the electorate.

More realistically, we need to give the existing Fed and the new governors appointed and confirmed the mandate or guideline that they need to minimize inflation and the loss of purchasing power and to track as close as possible to the stability of gold and other core commodities, products and services. I think that is what the Fed's mandate is already.

Problem is that, as discussed previously, we give this mandate mixed in with the reality that we are spending with no correlation to our means, we are creating future liabilities in amounts that are unfathomable, we are destroying our manufacturing sector and choosing to not produce our own energy - right as our demand for consumption increases - and so the dollars leave our economy and must find their way back in some other way. There is no way to achieve perfect balance among forces that are so far out of balance. In light of all these complexities, I actually think the Fed does a pretty good job.

Aren't we sitting on a gold mine?The price isn't right, but it doesn't matter -- all that glitters won't be sold

By Martha C. WhiteThe Big Money Sunday, November 8, 2009

Buried in the Treasury's International Reserve Position report is an intriguing bit of math. The document details the total amount, by weight, of the Treasury's gold reserves, plus a dollar value for said metal. But some fast division reveals something interesting: The Treasury marks the value of its gold at $42 an ounce, the price settled on in 1973, two years after the United States scrapped the Bretton Woods System, which had held gold at $35 an ounce for decades.

Wait -- what? Spot gold is heading toward $1,100 per ounce, and the Treasury is embracing a Cold War relic of a price? If the Treasury's bling were valued at the spot price, we'd be sitting on a literal gold mine of nearly $288 billion.

The purchasing power of the dollar in 1913, when the chart above begins, was close to what it was in the 1830s. As long as we were still on a gold standard (up to 1933), it was almost as though an external force was drawing the value of the dollar back toward that adjusted value. The Great Depression and the policy tools used to fight it severed the domestic link of the dollar to gold. The external trade deficits of the United States during the 1960s caused the final rupture of the international link to gold in August 1971.

So it seems linking the currency to a commodity helps stabilizes it.

Quote

It seems to me that there needs to be a human hand able to make an adjustment, a pressure relief, emergency assistance or human judgment to avoid a run, a panic or a collapse, especially in these times. We faced a deflation scare recently and we always seem to face an inflation threat. We had a country go under. We have states going under. We've had market crashes. We had one allegedly triggered by a computer glitch. I remember a near-cornering of the silver market by two brothers. We have droughts, trade imbalances and we have budget shortfalls in the trillions. We've had foreign wars and we had attacks on the homeland with our own planes that shut down entire industries. With a little discipline we could avoid some of these catastrophes, but not all of them.

I am far from sure in this subject but many of these things might not have been a problem if on the gold standard. I am unsure about trade deficits. The panics and the rest would be bearable if I was unworried about the loss of value of my currency. Now days inflation punishes those who are fiscally responsible and save some money for a rainy day.

Here is an article that I ran across while searching for more info. On a cursory read it makes some good points, stable currency, inflation proof, and hard to counterfeit, but I have just skimmed it, a lesson from Obama's admin. Reader beware. http://www.nolanchart.com/article3660.html

To answer the worries of converting back to gold standard:It seems to me if you linked the dollar to an ounce of gold it would be 1 dollar to 0.000909091ounce of gold. (1ounce/1100 dollars =0.000909091 oz to $) I guess the question would be how much gold and how many dollars are there? Maybe the solution would be to start another currency, 1 buck = 1 oz gold, then let it compete with the us dollar. The dollar would be phased out via market forces while the new currency takes over. With our electronic currency technology fractions of a "buck" would be easier to deal with and make the transactions more feasible. Many of these ideas came from this article http://www.tenthamendmentcenter.com/2010/04/11/ending-the-fed-from-the-bottom-up/

Any time I can get control over my own business/life and remove the government I feel better.

Now, with respect to boom/bust cycles prior to the Fed's existence, I would argue that virtually all of the boom periods were made possible by inflationary monetary conditions. Charles P. Kindleberger was a Harvard economic historian and definitely not Austrian in his thinking, but he showed in Manias, Panics, and Crashes, that monetary inflation was a factor in all of his studied boom/bust cycles. Rothbard also wrote a book about the Panic of 1819 and demonstrated that over issuance of bank notes was a factor there, too. In every historical case that has been studied closely, the cause of the boom and subsequent bust was consistent with the Austrian theory.

As I am sure everybody knows, a central bank isn't the only way we can get monetary inflation. It might interest some people to know, however, that the Fed is the United State's fourth central bank. The first three failed to get their charters renewed by Congress because so many people were convinced that they were dangerous scourges.

The gold standard in the US was never absolute. In the 19th century most banks were chartered by the states and they all practiced fractional reserve banking. When the banks made big mistakes and were unable to redeem their notes in specie, state legislatures often passed laws allowing those banks to renege on their contracts without being put out of business. It was always "temporary," of course, but it happened over and over. When a boom is created by monetary inflation it must always eventually come to an end, and once it does there is absolutely nothing that can prevent a recessionary environment during the period when malinvestments are liquidated.

To answer the worries of converting back to gold standard:It seems to me if you linked the dollar to an ounce of gold it would be 1 dollar to 0.000909091ounce of gold. (1ounce/1100 dollars =0.000909091 oz to $) I guess the question would be how much gold and how many dollars are there? Maybe the solution would be to start another currency, 1 buck = 1 oz gold, then let it compete with the us dollar. The dollar would be phased out via market forces while the new currency takes over. With our electronic currency technology fractions of a "buck" would be easier to deal with and make the transactions more feasible.

We have a ballpark figure of 288 billion dollars worth of gold and the amount of money owed to China and others is about 3.88 TRILLION. Do we just toss China the keys to Ft. Knox and the west coast? Do we tell everyone who bought a t-bill "whoops"? What of every American who holds dollars, most of which only exist in cyberspace?

To move the economy to a sound money system, the government only needs to get out of the way. We already have the private "GoldMoney" service that could expand into a serious payment system if the government would allow that to happen. Governments, however, jealously guard their coerced monopoly on money for a good reason: it gives them the ability to spend money they don't have.

Lots of people seem to think the small quantity of gold means that it could no longer serve as money. That idea comes from the inflationists' mindset ... the idea that an increase in the quantity of money causes economic growth. It's not true. Gold's most important monetary quality is scarcity; more gold cannot be brought into the economy without expending resources to find it, mine it, and process it. The problem with paper (or electronic) money is that it costs zero to make more. The nature of money is that people are motivated to make more of it until the value of the new money falls below its marginal cost. So in the case of paper money, the authorities will ultimately drive its value to zero.

Gold prices are arbitrary, especially with electronic record keeping. We could transfer any arbitrarily small quantity of gold from one account to another. To make gold money again, though, would require absolute rights to redeem the paper (or electronic chits) for gold and vice versa. That is the market mechanism that prevents over issue of paper.

It appears that China has more than 2 Trillion dollars in it's foreign currency holdings. Is there even half a trillion of gold in existance on the planet at current prices? Explain to me how this works out in practical terms.

Thank you GM for quantifying an argument I was trying to make. Besides the amazingly large number of dollars, we don't even have any way of truly measuring them and certainly no way of promising to redeem them, on demand, in gold. Yes we could peg the dollar to the current price of gold, and that ratio would never change - except in an emergency - but as mentioned recently, everything is an emergency - a crisis. Bankruptcy of our largest state (Calif.)is an emergency. Continuous war is an emergency. Collapse of our financial sector is an emergency, 9/11 was obviously an emergency etc.

So you would still have a Board (called the Fed) but you would just issue them a stronger directive to uphold the value of the dollar, which is already their mandate. But the value of the dollar with a new mandate would still only rely on the promise of the United States government (as it does now) and in the context of a government that already moved twice in its past to decouple further from gold.

In 1971 when Bretton Woods collapsed, it wasn't by choice. It was a no-choice situation brought on by previous policies, deficits and trade imbalances. If I were a Fed Governor, I would take the new mandate and then throw it back on congress: If you want the currency in balance then you will eliminate the budget imbalance NOW and legalize industry and manufacturing up the point where trade deficits are rounding errors, not rivers of currency flow.

My main point in bringing this up is that like-minded people, conservative and/or libertarian need to get on the same page, (like CCP says) and get our collective act together, give our leaders clear direction, (or keep losing). If ending the Fed is not an immediate possibility, priority or solution, like revisiting civil rights legislation is not, then we need to move the focus to only what we CAN achieve right now in the next election cycle, in the next congress and in the next Presidential contest. (IMHO)

Today the leading Austrian economic think tank, the Ludwig von Mises Institute held a conference at the University Club in Manhattan in which Marc Faber, famed contrarian investor and publisher of the “Gloom, Boom and Doom Report” gave his perspective on the financial crisis and his outlook for the future.

Below are his main points and entertaining quotes:

Central banks will never tighten monetary policy again, merely print, print, printBubbles used to be concentrated in 1 sector or region in the 19th century, but off of the gold standard this concentration has ended“The lifetime achievement of Greenspan and Bernanke is really that they created a bubble in everything…everywhere.”“Central banks love to see asset prices go up,” and their policy reflects their desperation to perpetuate thisUS housing bubble that Greenspan could not spot (even though he has recently spotted bubbles in Asia) stands in stark contrast to that of Hong Kong in 1997, where prices fell by 70%, yet none of the major developers went bankrupt; this was a result of a system not built on excessive debt like that of the US“You have to ask what they were smoking at the Federal Reserve,” during the housing bubble, as prices were increasing by 18% annually when interest rates started to steadily rise in 2004Over the last couple of years, when the gross increase in public debt has exceeded the gross decrease in private debt, markets have risen, whereas when private debt growth has outpaced public debt growth, markets have tankedThe next 3-5 years will be highly volatile

Americans must re-think what constitutes a safe asset; in a “traditional” period, one would generally rank from most to least safe assets: cash, Treasuries, corporate bonds, equities, commoditiesHowever, last year Economist Gregory Mankiw articulated the position which according to Faber essentially echoes that of Fed #2 Janet Yellen and pervades much of the Fed generally, that “The problem is that people are saving money instead of spending, and we have to get the bastards spending to keep the economy going,” so the key is to inflate the money supply at something like 6% per annumThus, Faber says “As far as I’m concerned, the Federal Reserve will keep interest rates at 0, precisely 0…in real terms”As such, cash and longterm bonds will be a bad place to hold one’s money; equities are an avenue to preserve wealth (but this is a risky proposition, given the effects of rampant currency depreciation); precious metals are a sound place for wealth preservationAs for the US being the most important economy for the world, there is a sea change going on right now; recently car sales in emerging economies (such as Brazil, China) are outpacing those of the US, Europe and Japan; oil consumption in emerging markets is increasing, while in the developed world it is contracting; the whole world does not depend on American consumption anymore – 60% of total exports are now going to the emerging world when one includes E. Europe; the US is still a large economy but it is not growing, while the growth in the emerging world is and will continue to be strong“People still think of emerging market economies as poor cousins, but because 80% of the world’s people are here, in aggregate the consumption is huge.”; these are not saturated markets and they are growing rapidly“Everybody should have 50% of their money in the emerging world, outside the West.”; people should also keep the custody of their assets overseasContrary to what the talking heads are saying, markets are not out of control, central banks are out of control printing moneyThe drivers of growth in the emerging world will be the urbanization of India and China; stocks won’t necessarily rise in the short term, but there will be significant growth in Asia in the long runThe shift in economic power from West to East has been remarkable in speed, largely due to the rapid industrialization of the emerging world and the speed at which information travels todayThere will be a massive increase in resource-intensive industries and new export markets, met with increased volatility and tension around the worldThe supply/demand characteristics of oil are great due to the need for oil in China, India, rest of AsiaOil is the top priority for China, as they are now a net importerUS has a huge strategic advantage over China given that we have access to our own oil, and that of Mexico, Canada, the Middle East and off the western Coast of Africa, in addition to the ability to travel on the Atlantic or Pacific Ocean; meanwhile, China sources 95% of their oil from the Middle East, and while they are building pipelines throughout Eastern Europe for example, their oil supply points in terms of ports for example are limited, and the US has defense bases surrounding these areas; Chinese subs could sink our boats however; the Russians are also not happy about our forces being in the region, and tensions will grow as the need for natural resources in these nations growsEventually, there will be war and one will want physical commodities “not paper from UBS or JP Morgan”In war, cities will not offer safety because one can get bombed, water may be poisoned, electricity shut off; instead, one should buy a house in the middle of nowhere/on the countrysideThe tremendous economic Sophism of the day is that a nation can print its way into prosperity; “If debt and money printing equaled prosperity then Zimbabwe would be the richest country.”“Mugabe is the economic mentor of Ben Bernanke.”Our fiscal situation is much more horrendous than it is made out to be; total debt (public and private) as a percentage of GDP counting unfunded liabilities is an astounding 800% of GDP, more than double that during 1929Sovereign credits in the Western world are all bankrupt, but before bankruptcy governments will print money; US government leaders will try to postpone the hour of truth, pushing the problems off till succeeding Presidents and CongressmenIf deficits didn’t matter as many like Economist James Galbraith argue today, why should citizens even pay taxes? It would make everyone happier if they didn’tFaber is sure that the economists in academia are intelligent and they study the textbooks hard, but they study the wrong textbooks and are totally inconsistent in their philosophyIn an environment of money-printing and high volatility that exists in the US and that will be created by future policy, physical gold is the best thing to ownOnce currency depreciation does take place, stocks may become very cheap, as happened when the Mexican peso depreciated by 95% in the early 80s, as the fund managers invested in Mexican equities completely undervalued them after currency collapseIn a nutshell Faber says he is essentially bearish on everything, though he favors commodities (especially physical precious metals and agriculture), owning a house in the countryside, equities in emerging markets tied to resources (especially necessities like water and oil) and healthcare, and most of Asia including especially Japanese stocksThere is no means of avoiding a total collapse in the West; at the first train station in 2008, the financial system went bust but didn’t die, at the next station nations will go bust (though this could take 5-10 years or less), but first they will print money as this is the most politically tenable option, and ultimately the world will go to warAll of us will be doomedBear in mind that Faber said all of this quite matter-of-factly.

Even if you disagree with his points on the trajectory of the West, it cannot hurt to understand and prepare for the worst case scenario while still hoping for the best.

<It appears that China has more than 2 Trillion dollars in it's foreign currency holdings. Is there even half a trillion of gold in existance on the planet at current prices? Explain to me how this works out in practical terms.>

Changing over to a new monetary system can be very painful and involve big losses to some people. We can't define the value of the dollar in terms of the current gold price, that's for sure. The number of dollars on the planet ensures that the equivalence would require an enormously higher gold price if we wanted the government to institute a new gold standard. To work out the details for this kind of transition would be a horrendous task. Jesus Heurta de Soto proposed a "banking reform" that would move a country to 100% reserve requirements, which would eliminate the monetary inflation caused by fractional reserve banking. You can read about it here: http://www.amazon.com/Money-Bank-Credit-Economic-Cycles/dp/1933550392/ref=sr_1_1?ie=UTF8&s=books&qid=1274904972&sr=1-1. I don't think it can ever happen within the US.

Instead of doing that, I would suggest we repeal the legal tender laws and let individuals within the economy use any form of indirect exchange that makes sense to them. Government's didn't invent money and governments are not necessary to define money. If the US dollar remains viable, that's what most people will continue to use. If other choices start working out better (GoldMoney, maybe?), freedom would allow people to employ those other choices and thereby keep the economy functioning. Consider Zimbabwe. Its currency collapsed and eventually the government lost its ability to dictate the definition of money. Subsequently, people in that country have used other currencies and no telling what else as expedient forms of money. The Zimbabwe economy would have been far, far better off if the government had eliminated its legal tender laws a long time ago.

The Chinese have been had; they are never going to be able to exchange all their dollars for anything with a value even close to what $2 trillion seems to represent at this moment.

US money supply plunges at 1930s pace as Obama eyes fresh stimulusThe M3 money supply in the United States is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history.

By Ambrose Evans-PritchardPublished: 9:40PM BST 26 May 2010

Comments 298 | Comment on this article

The M3 figures - which include broad range of bank accounts and are tracked by British and European monetarists for warning signals about the direction of the US economy a year or so in advance - began shrinking last summer. The pace has since quickened.

The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of insitutional money market funds fell at a 37pc rate, the sharpest drop ever.

"It’s frightening," said Professor Tim Congdon from International Monetary Research. "The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly," he said.

The US authorities have an entirely different explanation for the failure of stimulus measures to gain full traction. They are opting instead for yet further doses of Keynesian spending, despite warnings from the IMF that the gross public debt of the US will reach 97pc of GDP next year and 110pc by 2015.

Larry Summers, President Barack Obama’s top economic adviser, has asked Congress to "grit its teeth" and approve a fresh fiscal boost of $200bn to keep growth on track. "We are nearly 8m jobs short of normal employment. For millions of Americans the economic emergency grinds on," he said.

David Rosenberg from Gluskin Sheff said the White House appears to have reversed course just weeks after Mr Obama vowed to rein in a budget deficit of $1.5 trillion (9.4pc of GDP) this year and set up a commission to target cuts. "You truly cannot make this stuff up. The US governnment is freaked out about the prospect of a double-dip," he said.

The White House request is a tacit admission that the economy is already losing thrust and may stall later this year as stimulus from the original $800bn package starts to fade.

Recent data have been mixed. Durable goods orders jumped 2.9pc in April but house prices have been falling for several months and mortgage applications have dropped to a 13-year low. The ECRI leading index of US economic activity has been sliding continuously since its peak in October, suffering the steepest one-week drop ever recorded in mid-May.

Mr Summers acknowledged in a speech this week that the eurozone crisis had shone a spotlight on the dangers of spiralling public debt. He said deficit spending delays the day of reckoning and leaves the US at the mercy of foreign creditors. Ultimately, "failure begets failure" in fiscal policy as the logic of compound interest does its worst.

However, Mr Summers said it would be "pennywise and pound foolish" to skimp just as the kindling wood of recovery starts to catch fire. He said fiscal policy comes into its own at at time when the economy "faces a liquidity trap" and the Fed is constrained by zero interest rates.

Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown "Friedmanite" monetary stimulus.

"Fiscal policy does not work. The US has just tried the biggest fiscal experiment in history and it has failed. What matters is the quantity of money and in extremis that can be increased easily by quantititave easing. If the Fed doesn’t act, a double-dip recession is a virtual certainty," he said.

Mr Congdon said the dominant voices in US policy-making - Nobel laureates Paul Krugman and Joe Stiglitz, as well as Mr Summers and Fed chair Ben Bernanke - are all Keynesians of different stripes who "despise traditional monetary theory and have a religious aversion to any mention of the quantity of money". The great opus by Milton Friedman and Anna Schwartz - The Monetary History of the United States - has been left to gather dust.

Mr Bernanke no longer pays attention to the M3 data. The bank stopped publishing the data five years ago, deeming it too erratic to be of much use.

This may have been a serious error since double-digit growth of M3 during the US housing bubble gave clear warnings that the boom was out of control. The sudden slowdown in M3 in early to mid-2008 - just as the Fed talked of raising rates - gave a second warning that the economy was about to go into a nosedive.

Mr Bernanke built his academic reputation on the study of the credit mechanism. This model offers a radically different theory for how the financial system works. While so-called "creditism" has become the new orthodoxy in US central banking, it has not yet been tested over time and may yet prove to be a misadventure.

Paul Ashworth at Capital Economics said the decline in M3 is worrying and points to a growing risk of deflation. "Core inflation is already the lowest since 1966, so we don’t have much margin for error here. Deflation becomes a threat if it goes on long enough to become entrenched," he said.

However, Mr Ashworth warned against a mechanical interpretation of money supply figures. "You could argue that M3 has been going down because people have been taking their money out of accounts to buy stocks, property and other assets," he said.

Events may soon tell us whether this is benign or malign. It is certainly remarkable.

** While the Fed does not publish M3, it still publishes the underlying components. The indicator is reconstructed accurately for clients by Dr John Williams. See it here.

Bottom line: slow or negative growth in money today is "payback" for very rapid growth in money leading up to last year. There is no reason at all to think that there is a shortage of money in the U.S.

I would also note that M3 is no longer calculated by the Fed, but is cobbled together by various private sources. The Fed stopped publishing the M3 numbers long ago because they (correctly in my belief) concluded that M3 provided no useful information that was not contained in M1 and M2.

I have always followed M2, and I honestly do not see any cause for concern here.

I would also note that if there were a shortage of money, as the M3 alarmists are trying to argue, then how do they explain the ongoing rise in gold and commodity prices? or the abundant evidence of expanding global economic activity?